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What Overvalued Consumer Staples Mean For Dividend Investors

Summary

Low interest rates are encouraging investors to invest in “safe” consumer staples companies with high yields.

For example, retiring baby boomers want safety and yield. Iconic brands such as Procter & Gamble and Coca-Cola come to mind. But are they really safe?

Which of the top 10 holdings in the Consumer Staples ETF are better buys today if you must add new money?

Source: Author

I will use the top 10 holdings of the Consumer Staples Select Sector SPDR ETF (NYSEARCA:XLP) for illustration. The ETF follows the performance of the Consumer Staples Select Sector Index. As of April 14, the ETF's top holdings are as follows:

Company

*Price

*Yield

S&P Credit Rating

Weight

CVS Health Corp. (NYSE:CVS)

$102.2

1.66%

BBB+

6.1%

Colgate-Palmolive Company (NYSE:CL)

$71.3

2.19%

AA-

3.5%

*Prices and yields are as of April 15, 2016

XLP Chart

XLP is making new highs. And its top holdings are doing the same. The higher their prices go, the riskier it is to invest in them. However, some are less risky than others.

KO Chart

Why the Consumer Staples companies keep making new highs

The 10-year bond rate is 1.75%, which is at a decade's low. Anyone looking for income would gravitate towards quality, high-yield dividend-growth stocks that are perceived to be safe investments.

The top iconic consumer staples companies are seemingly safe harbors to park one's savings, especially the ones with yields considerably higher than 1.75%, including P&G, Coca-Cola, Philip Morris, Altria, Wal-Mart, and Pepsi that offer yields of at least 2.7%.

Procter & Gamble

While P&G is going through a multi-year transformation and shaving off its non-core brands, its earnings per share (EPS) has fallen. It's only natural that its dividend growth had to slow down as well. Is P&G really worth trading at a multiple of 22.3?

Last year, it hiked its dividend by 3%. This year, the hike was less than 1%. It's only prudent for P&G to slow down its dividend growth because its annual payout of $2.678 per share is estimated to be about 74% of 2016's earnings.

In the medium term, P&G's earnings growth is estimated to be 8%. I suppose this is meant for after it offloads its non-core brands. After which P&G becomes leaner and will be able to focus on boosting the sales of its remaining core brands. So, maybe some patient shareholders are willing to hold on to it for its yield north of 3%.

Coca-Cola

Coca-Cola is even more overvalued than P&G. Coca-Cola is trading at 23.3 times its earnings. Last time that happened, it was eight years ago in October 2007!

To make matters worse, Coca-Cola is expected to grow its earnings by less than 4% for the medium term. Last year, it hiked its dividend by 8.2%. This year, its hike was more than 6%.

If Coke's EPS continues to decline like it did in the previous two years, it really has no choice but to slow down its dividend growth as well. This is possible due to lower consumption of soft drinks in North America and other developed countries...


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